What Apple Is Wading Into: A Snapshot Of The K-12 Textbook Business

The battle for the college digital textbook market — including startups like Inkling and Kno — gets a fair amount of attention. But the K-12 textbook business that Apple (NSDQ: AAPL) now seeks to revolutionize is much less talked about outside of education circles.

Apple announced this week that it is partnering with the three largest K-12 educational publishers to sell iPad textbooks. It will be entering an $8 billion industry where most of the funds are controlled by state governments and school districts, which can mean long and politically charged funding discussions. Unlike in the college market, startups in the K-12 market have struggled to gain venture capital. One reason, on top of the bureaucracy that companies have to deal with: the digital infrastructure in many K-12 schools is weak, with an average of three students for every device as well as more mundane problems like too few electrical outlets.

That said, there’s clearly some real opportunity: While many assume the K-12 market is largely controlled by the three big companies that Apple is partnering with, in fact, more than half of that $8 billion market isn’t. Here’s a look at some of the challenges and opportunities awaiting Apple.

How big is the K-12 education market?

The market is estimated at $8 billion. There are 50 million K-12 students in public schools in the U.S.

K-12 school publishing — including elementary and high school textbooks and other teaching materials — is the second-largest publishing category in the U.S. after trade. Net sales revenue was $5.5 billion in 2010, according to the Association of American Publishers. (K-12 publishing net sales revenue fell 12.4 percent between 2008 and 2009, but increased by 7.1 percent between 2009 and 2010. Overall, net sales revenue between 2008 and 2010 declined by 6.2 percent.)

How is the K-12 publishing market different from trade and higher-ed publishing?

The main difference is that state governments and school districts procure about 90 percent of the books. “It’s very much unlike the consumer market where we decide to go into Barnes & Noble (NYSE: BKS) and buy a book,” says Jay Diskey, executive director of the AAP’s school division. “A school district will decide it needs a new reading program for its elementary school students and will request proposals from publishers. If the state likes the proposal, the contract is negotiated.”

Publishers don’t always sell the books individually; a parent may not be able to buy a single textbook, for instance. The AAP notes the average net unit price of a K-12 title was $65 in 2010, but extensive pricing data is difficult to obtain because so many books are bought in bulk by state governments and school districts.

Textbook rental doesn’t yet factor into K-12 education the way it does in higher ed, although some private and parochial schools are trying it.

Who are the main textbook publishers?

The K-12 textbook market is often seen as being dominated by just a few big companies, but that’s not entirely accurate, says Diskey. It’s true that three companies–McGraw-Hill (NYSE: MHP), Pearson (NYSE: PSO) and Houghton Mifflin Harcourt, the same three companies that are partnering with Apple in its new digital textbook store — capture about 85 percent of the K-12 core textbook market, which is worth roughly $3.2 billion. (The rest of that core market is made up of books from niche publishers on subjects like foreign languages, art and music, and books for technical and vocational schools.)

With the whole market estimated at $8 billion, though, there is still about $5 billion up for grabs outside of core textbooks. That portion includes many players, publishers and technology companies. They publish supplemental materials like workbooks, encyclopedias, books for teachers and reference works, all in print and digital formats. “There is far more diversity in the market than I think a lot of people understand,” Diskey says.

What is the role of digital?

Digital products are becoming a more important part of the K-12 school publishing market. Revenues from digital products increased by 45.6 percent between 2008 and 2010, to $638.7 million, according to the AAP. (The market for print books is still much larger but revenues from print products declined 13.7 percent between 2008 and 2010, to $2.6 billion.)

Spending on e-learning as a percentage of overall K-12 education expenditure is small, according to the September 2011 White House report “Unleashing the Potential of Educational Technology” — it makes up just $0.46 of every $100 spent, for a total of $2.9 billion. (Expenditure on e-learning in higher education is over ten times greater: $5.60 per $100 spent, a total of $24.4 billion.)

K-12 publishers all offer digital products now, but school districts have to decide how to buy them. The digital products are often bundled with print, but “a lot depends on the digital infrastructure in the school district and whether it can support digital learning,” says Diskey. “Not too many states have one-to-one student-to-hardware ratios. In order to have full-blown digital learning, students should have access to their own devices in the same way you had access to your own textbooks when you were in school.”

In fact, the national average ratio of students to hardware devices is three-to-one (three students for every computer, tablet, etc.) “That makes learning very difficult,” Diskey says — and is another way K-12 is different from higher ed. About 90 percent of students arrive at college with at least one electronic device like a laptop. netbook or tablet. “By and large, K-12 students do not arrive with these devices,” Diskey says. This raises questions about who will pay for the devices — family or school districts.

School districts must deal with more mundane issues as well, such as whether there are enough electrical outlets to charge devices. “Behind all this, there’s the backdrop of schools providing textbooks,” Diskey says. In many states, schools are required to fund textbooks, but those mandates don’t always extend to digital materials. It will take “massive funding” to provide the 50 million K-12 public school students with hardware.

How will digital adoption change in the next year or so?

“I think you’ll see more partnerships between publishers and hardware producers such as Apple and others,” says Diskey. “For a long time at the K-12 level, content providers and hardware developers have operated in different silos, but they need to be partnered. (The announcement by Apple) is very good for publishers — new softwtare tools and applications being developed means that more publishers, particularly smaller ones, can get into the digital market at the K-12 level. But there’s still a hangup at the school level with funding and availability of devices.”

What will encourage more entrepreneurship in the area? The White House report reiterates the challenges of selling new products into the market:

An important feature of the market for K-12 educational technology products is the large number of institutional purchasers, each with its own distinct curriculum and procurement process. The school district is the relevant decision unit for most institutional purchases. Selling an educational product to a school district may require substantial contact with a diverse set of actors, including state and local procurement officers who oversee funding streams, academic consultants who advise districts, key school board members, and principals and teachers in individual schools. Moreover, decisions about purchases often involve an extended timeline.

Those barriers help explain why very little venture capital is spent on K-12 education: “In the last five years, estimates suggest that venture capital has totaled perhaps $200 million annually for education companies, backing an average of 25 new businesses per year. This venture capital investment compares to $4.4 billion for biotechnology, $3.0 billion for medical devices, and $4.8 billion for software.”

In a paper on K-12 entrepreneurship, Larry Berger and David Stevenson, the founders of K-12 tech product company Wireless Generation, describe some of the “relatively simple steps that districts, policymakers, foundations and entrepreneurs themselves could take to work around the barriers or dismantle them entirely.” They suggest that school districts and states could form consortia “in which they pool their resources and their expertise to help bring a new product or service to market.”

Berger and Stevenson also say states should comission more research and development instead of requiring a finished product. “When NASA wants a new spacecraft, it does not expect Boeing and Lockheed to build it on their own dimes in the hope of getting the contract,” they note. “It invites the industry to submit proposals and sometimes even funds the early development of competing designs — and then it picks a team with which it will work closely to bring a new product into existence.”

Finally, Berger and Stevenson note, “Entrepreneurship is often driven by the search for, and discovery of, ‘disruptive’ technologies and business models that transform a sector. It is not easy to figure out how the education sector should welcome disruptions and innovations that do not exist yet, but a simple first step would be to ask for them — to articulate the demands that would inspire entrepreneurs to try to create a supply.”